A Business Practice’s Evolution

NEW YORK — Determining the origins of the chargeback is like trying to identify the first restaurant patron to press a $5 bill into the palm of a maitre d's hand. <BR><BR>It seems the development of chargebacks — and the related issue of...

NEW YORK — Determining the origins of the chargeback is like trying to identify the first restaurant patron to press a $5 bill into the palm of a maitre d’s hand.

It seems the development of chargebacks — and the related issue of markdown money — was evolutionary, not revolutionary, with people refining the idea over time.

Markdown money, said Morris Marmalstein, former president of The Warren Group, was the invention of Stanley Marcus and Vincent Draddy, former chairman of David Crystal, a sportswear manufacturer Draddy joined in the Fifties.

“One year Neiman Marcus bought too many dresses and Stanley said to Draddy, ‘Maybe I’ll charge you a few dollars for the dresses,'” Marmalstein related. “That was the first markdown money.”

In the early days, “You had relationships with buyers,” said Marmalstein. “While the transactions were spirited, there was a fairness. You don’t have that today. One of the last things that happened before I retired in 1995 was that a major store account said, ‘You owe us $100,000.’ I said, ‘I don’t owe you anything. You placed an order and I delivered it on time.'”

As for chargebacks, an executive identified by industry observers as key to their development was David Farrell, who was chairman and chief executive officer of May Co. from 1979 to 1998. Farrell is credited with coming up with the idea of charging vendors for shipping and labeling mistakes. He also has the distinction — viewed as a dubious one by some executives — of being an architect of the matrix, which imposes strict sales and profit requirements on vendors, narrowing the number of brands that are sold in stores.

Many believe the matrix and chargebacks work hand in hand.

“May Co. turned chargebacks into a science, and in some cases, a profit center with respect to shipping infractions,” said the former ceo of a regional department store, referring to penalties the retailer levied for late orders and improperly tagged garments.

“May Co. was trying to leverage its size to get the best deals possible,” said Kirk Palmer, a former May Co. executive who founded a self-named executive search firm. “The responsibilities of a merchant began to change and became more about deal-making than merchandising and product.”

This story first appeared in the June 7, 2005 issue of WWD.  Subscribe Today.

Another former retailer with a reputation for wielding a tough pencil in his day was Marvin Traub, former chairman and ceo of Bloomingdale’s. The stores believed the vendors should be responsible for making up the difference on a line that didn’t sell at full price.

Traub said the use of chargebacks and margin allowances started reasonably enough. “Vendors in the Eighties would say, ‘Why don’t you take an extra $50,000 worth of goods?'” he said. “The retailer would say, ‘Why don’t you guarantee the margins?’ Then the practice spread. Stores began to use it as a crutch and the vendors accepted it.”

Retailers also ask manufacturers for margin allowances at the end of a season when the vendor’s line has been marked down.

Herb Gallen, founder and former chairman and ceo of Ellen Tracy, was one of the first people to give markdown money to retailers if things didn’t sell. Gallen thought doing so would help secure a prominent place for the brand in department stores where bridge resources were fighting for real estate.

Before he sold the company in 2002 to Liz Claiborne, however, Gallen had a change of heart. He got tough on chargebacks and became a proponent of larger sell-throughs and marketing programs to encourage full-price selling.

Bud Konheim, chairman and ceo of Nicole Miller, traced chargebacks to the Seventies when vendors began manufacturing garments in China. The vendors had an epiphany: The cost of labor in China was one-quarter of the cost of manufacturing in the U.S. Companies placed larger orders and convinced stores to buy more garments. When the orders didn’t sell out completely, vendors offered to pay the difference.

“They created a monster,” said Konheim. “It was the greedy idea of, ‘Look at how much we can make.’ The vendors gave department stores permission to mark down the merchandise.”

“Instead of buying merchandise and fashion, stores bought deals,” said Elie Tahari. “The merchants are very guilty of that. It’s also our fault on the vendor side because we went along. For many years I held back and wouldn’t pay markdown money, but I couldn’t survive. The stores cut me off. I lost money because they cut my orders.”

There’s mistrust to spare on both sides. Retailers believe vendors build markdown money into the price of a garment to ensure they’ll make a profit. Vendors feel retailers are putting the screws to them and charging them for every conceivable infraction.